Even with bailout, mortgage delinquencies will likely worsen

— -- Not even one of the biggest government bailouts in history will immediately turn back the flow of home foreclosures and falling housing prices.

A proposed rescue plan that could cost up to $700 billion targets financial institutions and may ultimately ease a credit crunch that's tightened mortgage lending. But housing experts say foreclosures are likely to remain above historical norms until at least next summer as mortgages reset and home prices in some areas of the country continue to fall. One worry: Delinquencies, already a growing problem for subprime borrowers, are rising among prime mortgage borrowers.

The "proposal is positive for the housing market to the degree that it shores up the banks' ability to lend and prevents banks from closing their doors, that is key to finding stability for the housing market," says Susan Wachter, professor of real estate and finance at the University of Pennsylvania's Wharton School. "But it may not be enough."

The hitch? The growing number of foreclosures. Nationally, foreclosures rose 12% in August from the month before and were up 27% from the year before, according to RealtyTrac.

"There is no sign of it abating," Wachter says. "It is likely to worsen in the coming months. This has potential to drive down housing prices further.

"I do not expect a turnaround, unless prices stabilize, until 2010," she says.

Proposals before Congress have included a provision for loan modifications for mortgages the government assumes, perhaps averting foreclosures.

"I would think that this fund when it acquires whole loans will be working with the borrowers to renegotiate the loan," says Mark Zandi, chief economist for Moody's Economy.com. "Given what we're seeing the FDIC do, working with homeowners with mortgages from failed banks, this works to keep people in those homes."

More than 2 million foreclosures on homes financed with subprime loans are anticipated from late 2008 to the end of 2009, according to the Center for Responsible Lending. An additional 40.6 million homes will drop in value because they are near foreclosed homes.

"The foreclosures will continue unless we do something right now to mitigate the numbers of foreclosures," says Ginna Green of the Center for Responsible Lending. "We know it isn't just subprime loans anymore."

The number of delinquent mortgage holders grew in the second quarter, with 6.41% of payments late by 30 days or more, up from 5.1% the year before, according to the Mortgage Bankers Association. Prime loan delinquencies also rose in the second quarter, which drove the overall rate above the first quarter's 6.35%.

Still, subprime-loan performance points to problems ahead: 18.7% of subprime loans were paid at least 30 days late in the second quarter, up from 14.8% the year before. The number delinquent by 90 days increased for all types of loans.

Another concern about the housing slump: high lending standards. While more money may become available for loans, the strict standards mean that fewer people will be able to qualify for a loan than a couple years ago, when standards were looser.

"There is no question that lending standards for the foreseeable future will be high," says Jay Brinkmann, the MBA's chief economist. "If a bank now has an easier situation because of its capital position, if they look to take on additional risk, perhaps they are willing to be a little easier with credit."

Still, the government's package will not change the fundamentals of the housing market, Brinkmann says. "You'll still have too many houses in California, Arizona — way too many in Florida."

Some of the greatest concentrations of subprime loans are in the areas that saw the biggest price increases through 2005 and the steepest drops since then. Those areas also have the most houses in some stage of foreclosure.

California led the U.S. in August, with a third of all foreclosure activity. Florida's share was 14.5%, Arizona, 4.7%; and Nevada, 3.9%. Michigan and Ohio, two states in severe economic downturns, had 4.5% and 3.7% of all foreclosures, respectively, in August, according to RealtyTrac.

The rescue package may not solve all the housing market's troubles, but the market would face an even bleaker outlook without it, Zandi says.

"The events that we've gone through, despite the government's efforts, will hit the economy hard. We are in full-blown recession," he says. "Layoffs are going to mount and it will be a tough six to 12 months. But the housing market will be the least affected part of the economy because of these things the government has done to shore up housing."